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Editorial

Don't let high-frequency trading fear overtake clients

Apr 6, 2014 @ 12:01 am

Michael Lewis might have done investors a favor in the long run — but hurt them in the short run — with his allegation that the stock market is “rigged” in his new book, “Flash Boys: A Wall Street Revolt” (W.W. Norton & Co., 2014).

If individual investors withdraw from the stock market because they think they can't get a fair shake, they will suffer great harm in their efforts to accumulate retirement assets. That is because over the long term, stocks provide greater returns than bonds.

Investor confidence in stock investing already was shaken by the market crash of 2008 and was just beginning to recover. Mr. Lewis' charge might be the last straw for many.

It is up to financial advisers to educate their clients about the true nature of high-frequency trading — the subject of the book — and not allow his charge to dissuade them from investing in equities.

THE SKIM

In his book, Mr. Lewis focuses on the way high-frequency traders, using powerful computers and programs, and their proximity to major exchanges, can jump into and out of stocks ahead of the average investor, picking up a tiny profit — sometimes only a fraction of a cent — on every share traded.

He breaks no new ground in his charge. Others have pointed out the unfairness of high-frequency trading since at least 2007.

But Mr. Lewis' book, and his “rigged” claim on “60 Minutes,” has stirred up controversy.

In talking to their clients, advisers could point out that high-frequency traders don't rig the market in the sense that investors can't win. They simply skim a small amount off the top of every trade.

Before the advent of negotiated brokerage commissions in the mid-1970s, brokers charged far higher commissions to trade securities, a much higher “skim” than high-frequency traders extract, and no one thought that that rigged the market, though it certainly hurt investor returns.

Advisers also can point out that being out of the market is, in the long run, far more dangerous to clients' financial health than the practice of high-frequency trading.

A CLOSER LOOK

The good long-term result might be that because of Mr. Lewis' charge, and the publicity that it has received, the Securities and Exchange Commission, or even Congress, might be moved to do something to halt high-frequency trading.

Already, the FBI and Justice Department have said that they have been investigating high-speed-trading firms. If those agencies and the SEC find nothing illegal, Congress might have to step in and pass a law banning this kind of trading.

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